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Purchase Order Financing: How does it work?

Updated: Mar 13, 2023

But first, what is purchase order financing?

Purchase order financing is a cash advance that small-business owners can receive on their purchase orders. With PO financing, a lender will pay your third-party supplier up to 100% of the costs required to produce and deliver the agreed-upon goods to your customer.

Once your customer receives the goods, you invoice them for the fulfilled order, and they pay the purchase order financing company directly. Then, the PO financing company deducts its fees and pays you the rest.

You and the lender providing the funding are the only parties involved in traditional small-business loans. However, when you sign a purchase order financing contract, you'll frequently collaborate with the following parties throughout the procedure:

  • Your company/the borrower: You, who is seeking easy financing solutions to fulfill a purchase order for your business.

  • Purchase order financing company: the business providing the financing. This organization pays the supplier after verifying your purchase order.

  • Supplier: A third party that supplies or produces the products you distribute or resell. The provider is paid directly for its goods by the provider of purchase order financing.

  • Customer: The buyer of the goods is your customer. In a purchase order financing arrangement, your customer typically pays the financing company directly after receiving the goods.

Here’s a breakdown of how purchase order financing works:

1. You receive a purchase order.

A sizable order is placed with your company by a client, but you don't believe you have the inventory or cash on hand to fulfill it. 2. You determine the costs.

You reach out to your supplier to determine how much it will cost to complete the order. Based on the cost assessment your supplier provides, you can confirm whether you’ll need to apply for financing to fulfill the order. 3. You apply for purchase order financing.

The next step is to choose the best provider of PO financing, submit an application, and hopefully get approved after deciding that you need PO funding. Along with your application, you must submit the purchase order and the supplier's cost projection. Depending on the qualifications of your company, the track record and reputation of the supplier, and the creditworthiness of the customer, the financing company may approve you for up to 100% of the supplier's costs. It's important to remember that if the financing company only approves you for a portion of funding, let's say 90% of the supplier's costs, you'll be responsible for the remaining 10%. 4. The financing company for purchase orders pays the supplier.

Once you've been given the go-ahead, the company that handles purchase order financing will pay your supplier to produce and deliver the goods required to satisfy the customer's order. A letter of credit is a formal bank guarantee that payment will be made once certain conditions are met, in this case, when the goods are shipped and proof of shipment is provided. Many financing companies will pay suppliers using a letter of credit. 5. The supplier delivers the goods to the customer.

The supplier ships the goods directly to the customer. Once the customer receives the goods, the order is complete. 6. You invoice the customer.

You send the customer an invoice for the order after they've received the goods. Additionally, you deliver the invoice to the provider of purchase order financing. 7. The customer pays the purchase order financing company. The customer pays the financing company directly for the full price of the invoice. 8. The financing company deducts its fees and transfers your funds. The company that provides purchase order financing deducts its fees after receiving payment from the customer and pays you the remaining balance from the proceeds. If purchase order financing isn't right for you, check out Debtworks' list of the best alternative funding options for business owners.

Our recommendations are based on the market scope and track record, a business owner's needs, an analysis of rates, and other factors to help you make the best financing decision.

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